Spot month margin
This is an additional rate of margin which is charged by the clearing
house to cover the risk that they incur between the last trading day
of a contract and its ultimate delivery. It covers the risk of a default
during the delivery process.
There are no offsets allowed for spread positions. The clearing
house on settlement day 1 releases initial and spot month margins,
once they are satisfied that delivery has been effected correctly.
Margin methods
The method for calculating margin also varies from clearing house to
clearing house. It may be different for futures and traded options.
However, in 1988 the CME devised a method known as SPAN. This
risk-based margining system is now used by many exchanges for
the calculation of the initial margin on futures and options. Most
exchanges that have adopted SPAN have ‘tweaked’ it for their own
particular use and therefore there are different versions in use. For
example, Euronext.liffe use London SPAN.
The SPAN looks at a set of 16 possible changes in market conditions
within the boundaries of the risk parameters set by the clearing house
which is known as the risk array. The profit or loss for one long posi-
tion in each futures and options contract is worked out under each
scenario, for valuing positions. By combining all of the individual
arrays, London SPAN determines the scanning risk, which is the worst
possible loss for the portfolio.
Each position in the member’s portfolio is calculated and totalled
across the same underlying contract. The final result is the largest
potential loss for the portfolio, which is charged as initial margin.
London SPAN uses pricing models to calculate the option prices.
The Binomial model is used for equity and index options but the
Black-76 model is used for options which are priced off the future.
The parameters are set using both the historic and the implied
volatility of the contract, and in agreement with the exchange.
A detailed example of SPAN is given in the appendices.
Margin offsets
Where investors in a market employ particular trading strategies the
clearing house may allow certain reductions in the margin require-
ments to reflect the reduced risk of the position.
128 Clearing and settlement of derivatives
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